Sesterce’s take on: Why the mining industry has turned its back on PoW?

Written by
Sesterce Team

Sesterce’s take on: Why the mining industry has turned its back on PoW?

Written by
Sesterce Team

Sesterce’s take on: Why the mining industry has turned its back on PoW?

Written by
Sesterce Team

This is part 1 of a 3 part series :


Part 1 : Myths about PoW energy consumption and lack of efficiency


Part 2 : The business of “Staking”


Part 3 : Witnessing the next flippening, PoW vs PoS


In this first part Sesterce will present : I) The rhetoric about PoW being an environmental disaster ; II) Mining misconceptions and the new narrative ; III) The assumption that PoW will not be sustainable for miners.


Part 1 : Myths about PoW energy consumption and lack of efficiency


I) The rhetoric about PoW being an environmental disaster


There is a growing idea within the blockchain ecosystem that Bitcoin and Proof-of-Work based projects in general are going to “melt the planet”. This idea, heavily relayed by traditional medias and Bitcoin critics is based on the amount of power (i.e Electricity) that is being consumed by the network in order to secure transactions and the integrity of the Blockchain. Indeed, the introduction of ASIC’s to the market has resulted in a massive increase in the network Hashrate compared to the previously used GPU’s that were not optimized for mining cryptocurrencies.



In this chart you can see precisely when ASIC’s where introduced but especially the efficiency gains in terms of Hashrate/PowerUsed. (Full report from BloombergResearch)


However, most of the reports, especially the results on the analysis provided by Alex de Vries (a PWC consultant and author on Digiconomist) have received their fair share of criticism from the community. De Vries has based his whole analysis on a deliberately misleading calculation of “the electricity consumption per transaction” which, as described by Dan Held in his excellent rebuttal, is wrong for the following reasons :


The energy spent is per block, which can have a varying number of transactions. More transactions does not mean more energy


The economic density of a Bitcoin transaction is always increasing (Batching, Segwit, Lightning, etc). As bitcoin becomes more of a settlement network, each unit of energy is securing exponentially more and more economic value.


The average cost per transaction isn’t an adequate metric for measuring the efficiency of Bitcoin’s PoW, it should be defined in terms of the security of an economic history. The energy spend secures the stock of bitcoin, and that percentage is going down over time as inflation decreases. A Bitcoin “accumulates” the energy associated with all the blocks mined since its creation. LaurentMT, a researcher, has found empirically that Bitcoin’s PoW is indeed becoming more efficient over time: increasing cost is counterbalanced by the even greater increasing total value secured by the system.



You can see Capex cost decreasing over time (BloombergResearch)


As the cost of mining will shift from Capex (cost of capital invested in specialized hardware such as ASIC’s) toward Opex (energy cost to operate, $/MW) miners will tend to be mobile and setup their farms where a surplus of electricity is generated with the lowest marginal cost available. This is yet another advantage of the Bitcoin Network being able to rely on more than a single location to operate. As a result, miners will become a positive externality for energy markets across the world.


“The cost of Bitcoin mining becomes the lowest (excess) value of electricity.”


This will help solve the biggest problem of renewable energy yet, wasted production. Take hydro-electric power for example. Much of the energy consumed by the public is concentrated during specific hours, when you come home after work, when you heat your house in the morning… but, during quieter hours, the energy being produced is wasted.


In the future, you could imagine renewable energy project becoming profitable because of the perspective of bitcoin mining, this is especially true with sources of energy having an unpredictable output, when production is higher than anticipated, just plug in the miners. This is a win-win situation.


If anything, Bitcoin’s PoW can act as the buyer of last resort for all electricity, creating a floor that incentivizes the building of new energy producing plants around disparate energy sources that would have otherwise been left untapped.


“This global energy net liberates stranded assets and makes new ones viable. Imagine a 3D topographic map of the world with cheap energy hotspots being lower and expensive energy being higher. I imagine Bitcoin mining being akin to a glass of water poured over the surface, settling in the nooks and crannies, and smoothing it out.” Nic Carter


Furthermore, you can easily imagine making the Capex more efficient by introducing a secondary utility to the primary utility that is mining. The race to create the first “Mining Heater” is on and it would allow an increased efficiency of the energy used for producing a Block as the heat produced by the miner would not be wasted. (A secondary consequence of using heat from miners would be that the cost of cooling hardware becomes much lower)


This theory has already been proven to be right as a report from CoinShareshas come out stating that 74.1% of Bitcoin mining is powered by renewable energy. For the Sichuan Province which accounts for an estimated 50% of the global hashrate, this rate goes up to 90.1% powered almost exclusively by hydro-electric dams. Overall this make cryptocurrency mining the most renewable-driven industry in the world.


Everything in the universe uses energy (work). Postulating PoW is a ‘waste’ is subjective. Trading energy for trust (allowing permissionless settlement) is worth it to some (it’s profitable) so fundamentally is not a waste.


Bitcoin critics are not only wrong calling it a waste of resources, they are totally missing the point of why it has to be secured by such an important infrastructure of miners.


II) Mining misconceptions and the new narrative


The main argument from the proponents of less energy intensive form of consensus will tell you that proof-of-work is wasteful and that those calculations should be used for something more useful such as finding prime numbers. This narrative is gaining many supporters blindly advocating for cryptocurrencies to be secure by more “eco-friendly” alternatives.


But are the 28 Billion dollars of taxpayer money spent annually on printing new bills “worth” the effort? With a yearly operating cost of about 5 Billion dollars and 200 Million GJ of energy consumed, Bitcoin is barely a contender compared to the entirety of the banking system, or of the gold industry for that matter ($105B Yearly cost and 475M GJ of energy deployed).


Narratives are extremely important in the crypto world and narratives based on imprecise assumptions (to say the least) usually fail or are forgotten.


You'll see how narratives have been fading in and out of exisence. Visions of bitcoin in the chart above found in Nic's Carter



As Nathaniel Whittemore “Market Narratives Are Marketing: Introducing The Crypto Narrative Index” explains :


Investors invest in or against narratives; builders build directionally towards narratives; commentators race to associate themselves with the dominant narratives or, alternatively, to be the contrarian positioning against the conventional wisdom.


Market narratives are marketing. The incentives to push a narrative can be financial, like an investor sharing a view of the world that would just so happen to benefit them if more people were to agree with them and invest accordingly. In this way, narratives are attempts at self-fulfilling prophecy. Incentives can also be even simpler, however, such as the desire for status and community relevance. The fact that narratives are marketing is not a bad or malicious thing. Indeed, there is value in an emerging industry enabling a space where people can discuss narratives, they see trending.


This is especially true in the crypto space, in which content from investors and builders today has an outsized influence on market sentiment relative to neutral third-party research firms or data-driven journalism. Again, this is not in and of itself a problem. It is a good thing to get live insights into how operators see things. Moreover, the independent, data-driven research/journalist side of the market is catching up quickly which is accelerating the critical analysis of these narratives.


The same thing could be said about consensus forms.


As a result, it is necessary to explain WHY? Why Proof-Of-Work is, to this day, the most secure way to guarantee the integrity of a chain.


Everything requires energy (first law of thermodynamics). Claiming that one usage of energy is more wasteful than another is completely subjective since all users have paid market rate to utilize that electricity.


“If people find that electricity worth paying for, the electricity has not been wasted. Those who expend this electricity are rewarded with the bitcoin currency.” — Saifedean Ammous


The first error can be found in the idea that Proof-Of-Work is comparable to Proof-of-Stake or other distributed forms of consensus.


Gregory Trubetskoy explained that security is a secondary side-effect of PoW and that an interesting way to look at it is thinking of PoW as a clock, a decentralized clock. I could only recommend reading the full extent of Gregory point of view here:


In a nutshell he demonstrate that : “Proof-of-Work is primarily a mechanism which accomplishes a distributed and decentralized system of timing, i.e. a clock.”


Note that his writings aren’t about Proof-of-Work per se, he explains how the blockchain takes advantage of it. It must be stressed that the impossibility of associating events with points in time in distributed systems was the unsolved problem that precluded a decentralized ledger from ever being possible until Satoshi Nakamoto invented a solution. There are many other technical details that play into the blockchain, but timing is fundamental. Without timing there is no blockchain.


The Bitcoin Difficulty adjusts dynamically so that a proper hash is found on average once every ten minutes. The state of the chain is reflected by its blocks, and each new block produces a new state.


The blockchain state moves forward one block at a time, and the average 10 minutes of a block is the smallest measure of blockchain time.


The difficulty in finding a conforming hash acts as a clock. A universal clock, if you will, because there is only one such clock in the universe, and thus there is nothing to sync and anyone can “look” at it.


It doesn’t matter that this clock is imprecise. What matters is that it is the same clock for everyone and that the state of the chain can be tied unambiguously to the ticks of this clock.


This clock is operated by the multi-exahash rate of an unknown number of collective participants spread across the planet, completely independent of one another.


As we’ve seen, it is work that guarantees the security on the chain, and although this work being produced by miners is energy intensive, it’s worth it in the long run, as the clock ticks and the blocks add-up. However, some will say that Bitcoin security will not be able to withstand its current level as block reward decreases (i;e Halvings).


III) PoW will not be sustainable for miners


Approximately every 10 minutes, a new Bitcoin block is created, which contains newly minted Bitcoins (the “block subsidy”) plus transactions (which includes transaction fees paid by the entity sending the transaction). The value of the newly minted coins plus transaction fees is called the “block reward.”


Per Bitcoin’s hard coded monetary policy, the amount of newly minted coins per block decreases over time, eventually reaching 0% in the year 2140 (also known as a disinflationary model). At the time of this article being published, over 84% of all Bitcoins that will ever exist have already been minted, and the current annual inflation rate is just 3.8%. Over 99% will be mined by 2040.


So why does this matter? The block reward incentivizes miners to protect the network. As inflation trends towards zero, miners will increasingly obtain an income only from transaction fees. Some worry that transaction fees alone won’t provide adequate compensation for the miners. In storing large sums of wealth, security and trust are critical. This fear could incentivize miners to stop their activities and concentrate on staking coins to guarantee future rewards. Indeed, as we’ve seen in the last part, reward in a PoS or DPos system are substantially more predictable. The original arguments* from Dan Held are way longer but for the needs of this article we will only focus on Bitcoin Security Model



“As the number of users grows, the value per coin increases. It has the potential for a positive feedback loop; as users increase, the value goes up, which could attract more users to take advantage of the increasing value.” Satoshi Nakamoto


While the two represent the same security budget, the block subsidy and transaction fees are very different. For the block subsidy, its value is both as a rational way to issue new Bitcoins and as a viral FOMO loop built into the protocol, which increases the number and network effect of believers in Bitcoin. We’ve recently seen the same thing happen with the long anticipated Litecoin Halving. It further stretches out the need for transaction fees to solely provide security. Hence why it’s called a “subsidy.”


Over the long term, an organic tradeoff will occur: as network effect becomes larger, demand for block space increases, thus decreasing the need for a block subsidy. While we don’t know why Satoshi chose Bitcoin’s issuance schedule specifically, we can speculate. Four years between halvenings is a long time to plan and build. In similar duration, we give a US President four years to make things happen for an entire nation.*


In the chart below, we can see that transaction fees as % of market cap trend towards a little above 0.001% daily over the next decade. Even with the continual decline of the block subsidy, total mining revenue (ie security) has increased exponentially as Bitcoin gains further adoption.


Left Y-axis is daily mining revenue in USD. Right Y-axis is transaction fees/block subsidy as % of marketcap


With modeling done by Awe and Wonder we can see that around the year 2030 transaction fees will begin to consistently represent a healthy portion of the block reward. When transaction fees represent greater than 50% of the block reward for long periods of time (YoY), Bitcoin evolves to surviving more on transaction fees.


We have empirical evidence that total fee revenue will slowly trend up to equal the block subsidy in the coming decades. Based on this data, fears that the transaction fee won’t replace the block subsidy are definitively overblown.


The chart above shows transaction fees as a percentage of the block subsidy slowly increasing over time. - @Awe_andWonder on Twitter


The tradeoff is always between inflation (block subsidy) and fees and Bitcoin is the best positioned to charge fees reliably. If there is no economic (transaction) volume bitcoin will have failed anyways.


“I’m sure that in 20 years there will either be very large transaction volume or no volume.” Satoshi Nakamoto


Furthermore, a new report by Binance Research is showing that Merged Mining could be a solution to the block reward decrease problem. Merged mining refers to :


“the use of the work done for one blockchain (i.e. parent blockchain) on other smaller child blockchains, using Auxiliary Proof of Work (AuxPoW). In summary, merged mining relies on a reputable set of miners from a relatively more established coin in order to secure other (smaller) blockchains, at no added explicit cost to the larger chain’s miners.”


It was first introduced by Satoshi in a bitcointalk forum post.


This could play a decisive role in how child chains support decreasing mining rewards of parent chains such as Bitcoin and Litecoin. Every four years, both Litecoin and Bitcoin are scheduled to halve their mining rewards. With increased competition from the proliferation and development of layer-2 solutions, Bitcoin and PoW coins may eventually provide lower incentives for miners to continue operations, as their revenue streams from transactions volume could potentially decrease, with Bitcoin becoming even further used as a store of value rather than a medium of exchange. The aim of the introduction of merged mining was to disincentive miners of large and established cryptocurrencies like Bitcoin to switch their mining activities to emerging cryptocurrencies.


The case study also proposes that, merged mining may also potentially serve as a solution to maintain such legacy blockchains (e.g, Litecoin, Bitcoin). If new child blockchains were to be added through merged mining, these could potentially bring an extra stream of revenue for miners, significant enough for miners to maintain their operations for mining both (and all) chains. However, many risks (known and unknown risks) could be associated with AuxPoW such as concentration of mining pools and increased dependency -interdependency of the blockchains. Only time and experience will tell us if this could be a viable solution (i.e Litecoin upcoming halving with Dogecoin as an AuxPoW chain).


So, in the first part of this 3 part series dedicated to understand why PoS is becoming so popular despite the clear advantages of PoW, we’ve seen that the main source of criticism concerning Bitcoin (and Proof-Of-Work coins) was indeed largely misrepresented and was part of yet another narrative aiming to discredit, by lack of understanding or malicious intent, the decentralized model of trust created by Satoshi Nakamoto.


Arguments in this article were taken from multiple people I like to get insights from within the community. Thinkers and researchers including: Neil Woodfin, Nic Carter, Dan Held, Awe_AndWonder, Derek Hsue, Gregory Trubetskoy and of course, Satoshi Nakamoto.